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Monthly Archives: November 2012

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A very enlightening video available on YouTube explains clearly how malfeasance arising from a centrally-planned monetary system leads to wider swings in business cycles.

In the limit, monetary mischief may lead to rising consumer prices. However, a more important impact is that it introduce distortions into the production structure that leads to wealth destruction after an initial period of euphoria arising from an artificial but unsustainable economic boom.

This consumption of capital is just as devastating as though factories were put to the torch.

Alas, most central bankers seldom contemplate the logic laid out in this simple video.

Economists that support free & unencumbered markets whereby individuals are free to choose often champion great thinkers of the “Austrian” tradition. However, many are unaware that a Swedish economist, Knut Wicksell, belongs in their pantheon of intellectual heroes.

It is said that Wicksell was inspired to become an economist by being exposed to the work of Eugen Böhm–Bawerk who himself was a student of Carl Menger. But it was left to Wicksell to develop a monetary theory that both influenced mainstream economic thinking & was the theory of interest that inspired Ludwig von Mises.

For his part, Wicksell conceptualized how a central bank induces a “bank rate of interest” that differs from the “natural rate” leads to distortion (i.e., malinvestments) that undermine economic performance. As it is, discussions about the Austrian theory of interest must begin with Wicksell.

Wicksell also made an early contribution (1896) to the development of a tax theory that compared taxes to prices based on the microeconomics. In this regard, he greatly influenced James Buchanan & helped pave the way for Public Choice economics.

In turn, Wicksell provided guides for placing tax policy into the hands of individual citizens. As such, he began a tradition that was later the central concern of Austrian economists.

Knut Wicksell was also a great Classical Liberal & social reformer in the spirit of Bishop Francisco Marrouin of Guatemala whose humanitarian work inspired the founders of that great university. Not only was Wicksell an outstanding & original thinker in economics, he also excelled in mathematics.

It turns out Knut Wicksell’s name was recently added to a mural at UFM commemorating the intellectual giants that guide its mission: to provide education to support the development of a community of free & responsible individuals. (Look below & to left of image of Böhm–Bawerk.)

Implicit to their ardor for policy targets is that certain government agents or agencies should & can implement economic policies. That is, certain policy interventions are necessary & that they will have the desired effects.

Set aside for the moment that the individuals that are meant to hit these targets have ideological biases, human frailties & depend on incomplete/incorrect information. And ignore “public choice” issues.

Consider only that the analysis leading up to arguments involving policy interventions tend to overlook their microeconomic impacts. It is not that macroeconomists are ignorant of microeconomics; it is that they seem preternaturally incapable of considering the impact of their policy preferences on the decisions of households & firms.

Focusing on economic aggregates that are conceptually-imperfect & have numerous measurement flaws like GDP or CPI is a distraction from changes in relative prices. As it is, entrepreneurs are much more sensitive to changes in interest rates & movements in prices of their inputs than they are to reported macroeconomic data.

While conventional or unconventional (QE) monetary policy tools to inflate the money supply can boost nominal GDP or offset declining price levels, they tend to distort the production structure of the economy.

It turns out that a fixation on targeting leads macroeconomists to ignore the impact on capital spending whereby malinvestments as well as the emergence of asset or commodity bubbles.

Those of us that believe that entrepreneurial initiatives and rising private investment are the principal drivers of economic growth (with savings as the fuel) are disheartened by recent news from the Wall Street Journal.

“Half of the nation’s 40 biggest publicly traded corporate spenders have announced plans to curtail capital expenditures this year or next, according to a review by The Wall Street Journal of securities filings and conference calls.”

This may have grave consequences since Austrian business cycle theory (ABCT) predicts that investment spending tends to slow down before declining prior to the economy moving into a recession.

This week I will give several lectures on the nature & cause of “bubbles”.

One is with the Economics Honor Society at UFM: EN-601 at 2:30PM, Wednesday, 21 November.

Another is “THE RISE & DECLINE OF CHINA’S “BUBBLE” ECONOMY” on Thursday, 22 November from 12:30 pm to 2:30 pm in A-411.

China’s spectacular economic growth over the past 30 years can be explained as having 2 distinct causes.

The 1st part is a “good” story of an improved use of economic resources arising from the “marketization” of China’s economy combined with the triumph of globalization.

The 2nd part is a “bad” story that can be traced to China’s leaders choosing a defective economic model to guide their economic development.

Among the mistakes made by the Chinese leadership is an unshakeable faith in exports as the best way to drive economic growth that is responsible for serious economic imbalances. Unfortunately the best-&-brightest Chinese students that studied in foreign universities returned to oversee the implementation of Keynesian-inspired economic policies that are contributing to more imbalances.

However, the fundamental problem with China’s economic policies involve massive monetary malfeasance (i.e., excessive rates of growth of money supply & credit) that has created serious macroeconomic instability. Flooding the Chinese economy with cheap has blown an enormous domestic economic bubble while also spawning “mini-bubbles” in other countries that sell commodities to China.

Inasmuch as “anything-that-cannot-go-on-forever; will-not”, it is increasingly likely there will be an unhappy end to China’s economic success; perhaps sooner rather than later.

From the experience of all ages and nations, I believe, that the work done by free men comes cheaper in the end than the work performed by slaves. Whatever work he does, beyond what is sufficient to purchase his own maintenance, can be squeezed out of him by violence only, and not by any interest of his own.
~ Adam Smith. Wealth of Nations (1776) ~

In the 1st installments of his riveting Ibis Trilogy (“River of Smoke” & “Sea of Poppies”), Amitav Ghosh has several characters attempt to apply the logic of “free trade” to force Chinese authorities to accept a banned item, opium, & to justify armed intervention by the British military.

While there is much literary merit in Ghosh’s books, his depiction of the support of some individuals’ for free trade must be seen as being based on opportunistic & self-interested motives. Readers would do well to place the concept into both a philosophical & historical context.

Otherwise, they might walk away with misinformed views on the merits of free & open commerce. Indeed, it would be just as inappropriate to condemn democracy since it allowed such dictatorial horrors as Hitler, Hugo Chavez or Salvador Allende to acquire constitutional powers through the ballot box.

It turns out that the Classical Liberal underpinnings of free trade were developed in the context of opposition to slavery, colonialism & war.

Indeed, many Classical Liberal & Libertarian philosophers have been among the most ardent anti-war campaigners.

Just as Peron had his Evita, former president (now deceased) Nestor Kirchner left his country a dubious legacy with his wife, Cristina, serving as President. As all Peronist leaders before, support from the “descamisados” (shirtless ones) depends upon a endless & increasing stream of largesse.

Disasters with high or hyper-inflation has until recently taken excessively-loose monetary policy off the table. Also, high reported rates of consumer price inflation requires, according to law, upward adjustments in welfare payments & increased salaries for public-sector workers.

While the open dispute about the inaccuracy of statistics on rising consumer prices has Argentina is on the verge of being the 1st country to be censured by the IMF for not sharing accurate data about inflation and the economy. (“Not sharing” is apparently diplomatic speech being used by IMF officials that would not come out and accuse the regime of lying.)

Another indicator of the abject failure of the Argentine government is the fact that, outside of extreme authoritarian communist states, it is extremely rare for a modern economy to have a black-market exchange rate. Yet ever-tightening controls over foreign exchange & capital flows have inspired Argentinians to buy “blue dollars” that sell for at least a 30% premium over the official exchange rate.

When last I was in Argentina, I drew the parallel with the monetary & fiscal behavior going on there now with what preceded the disastrous collapse of the Weimar Republic. Just when I thought that the economic policies coming out of Buenos Aires could not get worse, they do!!!

“The economic laws must not be sought & cannot be found on the properly economic field. It is on the vital field, then, that the laws of economics must be discovered & studied, & the data of economics interpreted. To recognize this will be to humanize economics.”

The prices of risky assets began increasing in June of this year & continued until at least mid-September. Much of the rise in equity indexes can be explained by the flood of liquidity courtesy of the major central banks, especially the FED & the ECB acting on behalf of the euro-zone. (Dare anyone say, “bubble”!?!)

And so it is that institutional investors took the “sucker bet” offered by central bankers & stocked up on risky assets. Meanwhile, the Fed seems to be reducing the size of its own balance sheet, pursuing a stealth “exit strategy” by selling off over-valued assets from its portfolio to private buyers that now hold depreciating securities.

Meanwhile, many central banks are buying gold at historical rates. According to Thomson Reuters GFMS, central banks may increase their gold purchases to 493 metric tons this year as they already bought 273 tons in first 1/2 of 2012, up by 7.9% or 457 tons last year. This was 2nd time there has been an increase (1988 & 2010) & largest buy since 1964 such that the net addition to their gold stocks since 4th quarter of 2008 has been 1,290 tons.

And so, central bankers are offloading junk assets to private investors that believe that the floodgates of artificially-cheap money will flow unabated. And the same central bankers pile into gold as their handiwork causes the simultaneous collapse of paper currencies.